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K-Green Trust: A bad investment?

Wednesday, October 27, 2010

There has been much discussion regarding K-Green Trust (KGT) and its yield. I agree that KGT's estimated DPU of 7.82c represents a partial return of capital.

Unlike Saizen REIT which owns freehold properties, for example, KGT's assets have limited lifespans. At the end of their lifespans, they would be returned to the Singapore government and there is no guarantee that their concessions would be renewed and if they were renewed, at what price?

KGT has a total of 3 assets:

1. Senoko Waste-to-Energy Plant
(Concession: 15 yrs fr 1 Sep 09: 14 yrs left)

2. Keppel Seghers Tuas Waste-to-Energy Plant
(Concession: 25 yrs fr 30 Oct 09: 24 yrs left)

3. Keppel Seghers Ulu Pandan NEWater Plant
(Concession: 20 yrs fr 28 Mar 07: 16.5 yrs left)

The Senoko Waste-to-Energy Plant is estimated to contribute to 50% of the Trust's income.  The Tuas Plant is estimated to contribute to 35% while the NEWater Plant is estimated to contribute to 15% of income.

Assuming that KGT pays out 100% of its free cash flow (and this makes it a self liquidating trust), does not engage in any acquisitions over the lifespans of its three existing assets and continues to have a DPU of 7.82c (representing 100% of its free cash flow) while it still has ownership of the said assets, buying KGT at $1.11 would take 14 years to get back my investment.  By then, KGT would be left with its Tuas Plant and NEWater Plant, the Senoko Plant's concession having ended.

Assuming that its DPU is halved after taking away the Senoko Plant, DPU would become 3.9c. This would continue for 2.5 years before the NEWater Plant's concession terminates and we would get a total DPU of 3.9 x 2.5 = 9.75c. Then, we would be left with 7.5 years of concession for the Tuas Plant and assuming the DPU is then reduced by 30% to 2.7c, we would get a total DPU of 2.7c x 7.5 = 20.25c.  In total, I would gain 30c for the $1.11 I invested earlier in August over a 24 years period or a total of 27% return which means a simple return of 1.13% per annum.  This rather simplistic estimation, however, assumes that KGT maintains the status quo which I think is highly unlikely.

KGT is a business trust and it does not have a gearing cap. It could have a gearing level of more than 45% and as long as it is able to generate income in excess of its interest payments and any regular debt repayment, we could see DPU increasing.

If it could land lucrative acquisitions with cheap debt, we could also see it reducing its payout ratio and keeping cash for asset renewal purposes. To think of KGT as a static business trust with no growth opportunities could be rather short sighted.  Why? Because it has zero gearing unlike CitySpring Infrastructure Trust.

Remember that KGT has Right of First Refusal (ROFR) granted by Keppel Corp on four projects which, more likely than not, would be DPU accretive acquisitions as KGT would most probably fund these with debt to begin with since its gearing level is zero:

1. Biopolis DCS Plant Biopolis@one-north, Singapore
2. Changi DCS Plant Changi Business Park, Singapore
3. Woodlands DCS Plant Woodlands Wafer Fab Park, Singapore
4. Amotfors Energi WTE Plant Sweden

Of course, this assumption has its premise on KGT having a competent management team that would take care of unitholders' interests. This remains to be seen.

Would I buy more of KGT? At $1.00, the price I originally thought of on 3 July, I would.

Related post:
K-Green Trust: Weak technicals.


Anonymous said...

Hi AK,

The current real yield matches what I expected - the Trust yield should be similar to SGS bonds since the counterparty is the same (SG Govt). Naturally, it may seem lower but I guess the market has priced in growth in the revenues in the next 2 decades.

It will be interesting to estimate how much debt will be needed to boost the true yield to levels exceeding 4.5% (CPF) ?

Let me try -

Current Market Capitalization: $665 million

For the Trust to generate annualized returns of 4.5% over the next 25 years (assuming zero terminal value), it needs generate cash-flow equivalent to twice its market capitalization. This translates to around S$1.3 billion. I believe at the moment KGT is capable of distributing $0.9 billion (assuming similar rates for the next 25 years and no capex). So KGT gotta find an asset that can provide a further $400 million for 25 years AFTER repaying interest and loan. I don't think it will be easy unless they plan to leverage up 3-5X its NAV.

What do you think ? Or am I missing something here haha ???

Not a call to buy or sell...this represents my own fallible views. Please correct my figures if I missed anything out :)


AK71 said...

Hi Nick,

I was expecting you to comment on this. ;)

KGT has Right of First Refusal (ROFR) granted by Keppel Corp on four projects. How much would these be sold to KGT for? What's their free cash flow numbers? What would the distribution yield be? We don't know at this juncture.

Like you have pointed out before, business trusts could and often end up with very high gearing. So, assuming that KGT borrows up to 100% of the values of its future acquisitions and let's say it triples its total assets, its gearing level would still be slightly less than 100%, taking into consideration its current assets. Locking in debt cheaply could be a boon.

The lengths of the concessions of its future acquisitions would be an important consideration too.

CPF-IS is only applicable to CPF-OA which has a return of 2.5%, not 4.5%. In the above scenario, KGT could beat a real return 2.5% per annum.

For my investment in KGT, I am using funds in my SRS account which are untouchable till I am 62 years old and earn 0.1% per annum. So, for me, it's not too bad. ;)

Anonymous said...

Its ability to take on debt isn't a problem per se. Currently, its NAV is around $720 million. It can easily borrow another $1 billion to fund any major acquisitions. Assuming it clinches a massive 30 year contract with 8% yield (similar yield as KGT assets), its cash-flow will be boosted by $80 million annually. But debt needs to be repaid annually at around $35 million a year so its net cash-flow will be around $40 million. This is a pretty large sum and should be able to double the net distributable amount annually.

But even after raising so much debt, its real dividend yield (based on current price) will still be quite low as compared to other equities.

I guess it is critical to understand what exactly this stock is. To me, this is simply a SGS bond with variable growth rates included inside. If you are seeking an investment that can yield 2-5%, this is a pretty good investment.


PS: This is guess work - plain and simple. :)

AK71 said...

Hi Nick,

Absolutely, I am just making a guess that they would, more likely than not, make acquisitions which would be distribution accretive. Guesswork but reasonable guesswork. ;)

What we have done so far is FA. TA shows that the price of $1 per unit is the historical low (which should be fresh in the minds of market participants) and we could see some strong support at that level which is partially why I would buy at $1 anyway.

Let's see how things turn out. Thanks for the comments. :)

Anonymous said...

K-Green reach 1 dollar today.


AK71 said...

Hi TN,

S$1.00/unit now is different from S$1.00/unit a few months ago. It would have to be lower now for me to consider adding to my position. ;)

Deception said...

Initially NEA wanted to sell away the Tuas South Incineration Plant, however their asking price was too high as it was the youngest among the four at that time. NEA was so happy when this company agreed of S$462 million to acquire their 17 year old rotten plant. Why another $48 million to upgrade SIP? Maybe its Electrostatic Precipitators were not able to keep the emission within the safety requirement? Do you think NEA would be slapping their own face with warning letter as a government agency? Well the much delayed Bag Filter project start to cast the concrete base this year, commission date has yet to be confirm.

KGT has 3 plant assets, 2 of them are losing money and only one had profited in last year report card. Then overall of the 3, KGT managed to squeeze the payout for their investor. If government had employed 3 personnel to operate and maintain one equipment, then KGT would be using one person to operate and maintain 3 equipments. Make a guess either the machine or the human will break down first? The government agencies had history in manage their plant and maybe Keppel trying to buy a shortcut or to prove cost saving? KGT make money when its assets burn waste and treat used water. Wonder if the Trust would hire a fisherman for a operator job or ask a farmer to do welding work?

Ulu Pandan NEWater plant had a death case of their staff in the plant in 2009 and is still pending MOM investigation.

The new incineration plant builded by Keppel in Tuas South was having efficient problem and will be going for modification later. Belgium Seghers sold Keppel an outdated design and the construction of the plant was way over their budget. Basically most of the materials and equipments came from China, some of it were second hand parts, some of them unable to use and became scrap or left in the warehouse.

Keppel approach NEA to appeal they wish to be the one to build and operate the sixth incineration plant, do you think the government would let a company monopoly their market?

AK71 said...

Hi Deception,

It seems that you are privvy to some insider information. By this, I guess, you could be an industry insider or a company insider.

Obviously, I do not have the answers to your questions. ;)

My initial smallish investment in this Trust is still untouched. I wait to see what the management would do next.

Without any gearing at the moment, the Trust has the potential to bump up distributable income by quite a bit and that would be a positive catalyst.

If the Trust remains the way it is through the years, then, it would indeed be a bad investment.

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